Notes from the Edge of a Market Correction

We’re still on vacation, which means that we’re still reckoning, but even less seriously than usual.

Last Thursday, the stock market seemed to hesitate. It didn’t know whether to go up or down…so it did nothing.

On the other hand, the price of gold had made up its mind even before the markets opened; it scooted down more than US$20.

What’s the matter with gold? We don’t know. But we’re curious about it and eager to know. Are speculators unloading gold to shore up positions elsewhere? That’s what some commentators think. But of all the things one might sell to raise cash, gold seems like the last one we’d want to get rid of – especially when you look at the state of the markets.

As we point out in our soon-to-be released book, Mobs, Messiahs, and Markets, every market is a public spectacle. And every public spectacle follows a certain pattern. It begins with lies and humbug – ’emergency’ low lending rates from the Fed…faith-based currency…stocks for the long-run. Then, it progresses into farce – hedge funds…low-doc mortgage loans…and ‘cove-lite’ LBO financing. And finally, it ends in disaster.

We have seen plenty of humbug and farce. The disaster phase is beginning now. Countrywide Financial (NYSE: CFC) – America’s largest mortgage lender – may be facing bankruptcy, according to Merrill Lynch (NYSE: MER). The stock has been cut in half so far.

More importantly, both Home Depot (NYSE: HD) and Wal-Mart (NYSE: WMT) – America’s largest retailers – are warning that earnings ain’t what they used to be. Could this be the long-awaited signal that the consumer is finally cutting back? Maybe.

Q: How do you read the events as they have unfolded in the past fortnight? How do you think this might shape up?

A: Basically as you know, the US market went up until July 16. The Dow peaked out on July 17 above 14,000 and then it started to slide, mainly driven this time by financial stocks and by what people call a crisis in the subprime lending sector and the CDO and the BS markets. The question obviously is where do we go from here? Is it like ’98, where we dropped first and then recovered strongly towards the end of the year? Or is it something more serious? I think it’s something more serious.

Q: If you had to predict…since your view is bearish, what percentage fall would you expect in emerging market equities, on an average, over the next foreseeable period?

A: Well, I think the S&P has a very good chance to decline by 20-30% and emerging economy stock markets, I think they could drop by 40%. That may not mean that the bull market in emerging market is over for good, because in ’87 we had drops in Taiwan of 50% and then the market went up another four times; so you can have big corrections and still be in a bull market.

But if someone came to me and said, “What is the upside on, say, the S&P?” We had 1,452; the high was 1,555. I would say the upside and the big resistance in the market is, say, between 1,520 and 1,530 – so the upside is limited. But what about the risks?

What I noticed is investors are far more concerned to miss the next leg in the bull market on the upside, than about the risks of losing a lot of money. And I think, gradually this will change, and that will mean lower equity prices…and also prices of other assets such as commodities can go down substantially and obviously home prices around the world.

Daily Reckoning readers should be aware…this is a downturn that COULD be extremely long and severe.

Here’s another DR dictum: The force of a correction is equal and opposite to the deception that proceeded it. Never before in the history of the world have so many people believed so many things that couldn’t be true. Now, they owe more money to more people than ever before. And it could take a long, painful correction…or worse…to straighten things out. That’s why we would hold onto our gold. If we needed cash, we’d sell something else.

Bill Bonner

Best-selling investment author Bill Bonner is the founder and president of Agora Publishing, one of the world's most successful consumer newsletter companies. Owner of both Fleet Street Publications and MoneyWeek magazine in the UK, he is also author of the free daily e-mail The Daily Reckoning.

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